Episode 1 : The Silent Exit of Mode 2 Co-Lending (Policy Vs Practice)

Policy Vs Practice Series

Introduction

When RBI first introduced co-lending, the promise was simple — leverage the NBFC’s reach with the bank’s cost of funds. Two models emerged:

• Mode 1: Bank and NBFC co-lend from day one.

• Mode 2: NBFC originates, books the loan, then transfers the agreed share to the bank after a short period.

For years, Mode 2 was the operational workhorse — flexible, adaptable, and a perfect fit for products where disbursements happened in stages or where bank readiness lagged behind origination.

On August 6, 2025, a single line in RBI’s revised guidelines changed the game:

“The bank’s share in loans under co-lending must be booked within 15 days of the first disbursement to the borrower.”

Why This Matters

The 15-day cap is not just a compliance checkbox — it’s a structural kill-switch for many Mode 2 use cases.

Policy Vs Practice

The Mode 2 Viability Map (Post-Aug 6, 2025)

Product Category	Typical Disbursement Pattern	Transfer to Bank Feasibility (≤15 Days)	Mode 2 Viability	Reason for Impact
Two-Wheeler Loans	Single-day, low-TAT	✅ Yes	High	Quick disbursal; easy to meet transfer deadline.
Used CV Loans	7–20 days incl. valuation & RTO	⚠ Partial	Moderate	RTO delays may breach 15-day limit.
Machinery Finance (MSME)	Stage-wise release	❌ No	Low	Instalment-linked disbursements exceed 15 days.
Home Improvement Loans	Staggered based on work completion	❌ No	Low	Cannot transfer partial disbursements under Mode 2 structure.
Education Loans (Domestic)	Single release	✅ Yes	High	Works if release is immediate; not for instalment disbursals.
Education Loans (Overseas)	Tranches aligned to semesters	❌ No	Low	Semester gap kills transfer window.
Agri Equipment Loans	Linked to delivery from dealer	⚠ Partial	Moderate	Seasonal delivery delays can push beyond limit.
Project-Linked MSME Term Loans	Milestone-based	❌ No	Low	Almost all breach 15-day cap.
Working Capital Term Loans (WCTL)	Single release	✅ Yes	High	If sanctioned amount is released at once.
Invoice Discounting	Single-day post acceptance	✅ Yes	High	Fits perfectly with Mode 2 timelines.

Sector-Level Impact

1. Agri Machinery Finance

   • Before: NBFC could book the loan when farmer placed order, wait for delivery (often weeks later), then transfer share to bank.

   • Now: Delay in delivery breaches 15-day window → bank participation drops → NBFC funds the entire loan or shifts to Mode 1.

     
     

2. Project-Linked MSME Loans

   
   

   • Before: Funds released in phases after site inspection. Transfer to bank possible after first milestone.

   • Now: Milestone gap > 15 days kills Mode 2 feasibility → Mode 1 becomes default, even if bank risk appetite is lower in early stages.

     
     

Policy vs Practice: The Gap

• Policy intent: Faster booking, cleaner risk-sharing, reduced warehousing risk for NBFCs.

• Practical outcome: Entire product lines in NBFC portfolios lose Mode 2 viability.

• Unintended consequence: Push towards Mode 1 in products where banks historically had low appetite at origination stage.

  
  

Where Do We Go From Here?

• For NBFCs: Re-engineer disbursement processes to fit the 15-day cap or redesign products for Mode 1.

• For Banks: Build faster credit ops for milestone/staggered products or risk losing co-lending share.

• For Regulators: Consider sector-specific relaxations where staged disbursements are inherent to the product.

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Conclusion

Mode 2 was never just a loophole — it was a bridge between NBFC agility and bank prudence. The August 2025 directive doesn’t just change timelines — it changes the feasibility of co-lending for entire sectors.

If policy and practice don’t converge, we risk losing the very diversity in co-lending products that the framework was meant to foster.